An economist explains how demand for labor creates inflation — and what the Fed can do about it

Henry Blodget sat down with Carl Weinberg, Chief Economist at High Frequency Economics, to discuss the relationship between inflation and unemployment. Following a transcript of the video.

Blodget: Listening closely to the Trump Administration, they would say, 'Yes, but there's a huge pool of people who are out of the labor force because they've gotten very discouraged.' Some say about two million people. As they see the economy start to heat up, they will come back into the labor force and that will provide the growth in the labor force that you're talking about, without huge immigration.

Weinberg: Well, maybe. Alright, let's suppose you're on the Federal Reserve board. Okay, your job is to avert the worst possible outcome for the economy and from the point of view from your mandate, that worst possible outcome is a resurgence of inflation. All right, so if that's your job and all the historical experience tells us that if this particular metric of unemployment goes down any lower, then we're going to start to get wage increases, then it would be irresponsible for you to ignore all of that history, alright, in exchange for a recent political debating thread. And maybe future history will show that was wrong but given what we know right now is the time to step on the breaks is now before we get into some kind of uncontrollable situation. And again, when we look at the labor market unemployed claims for unemployment insurance are at historic lows. Every signal we're seeing from the labor market says it's growing at 1.5% per year and the labor force is only growing by 1%. Something has to give. The Fed's job is to arrest that process before it gets into it a territory where previously we've experienced inflation.

Blodget: Let's talk about what this means for the stock market, the economy overall. Are we anywhere close to a recession?

Weinberg:Well, we at High Frequency Economics, we don't have a recession in our forecast just yet. Having said that, we're not unaware of the fact that most of the recessions in the post-war period have been caused by policy, have been caused by the Fed stepping on the brakes too hard, too soon, too everything. Alright, so if history is any guide, a tightening of policy will probably lead to a slow at least a slowdown, if not a downturn of the economy. But we don't see any of the warning signals for that just yet in the actual economic data. So we're looking, we're watching, we're prepared for that eventuality. But it's not our baseline forecast right now.